Survey
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
* Your assessment is very important for improving the workof artificial intelligence, which forms the content of this project
1 Heading Upstream: A Route to Commodities that Bypasses the Futures Market Elizabeth Collins, CFA, Associate Director of Equity Research, Basic Materials Upstream and downstream producer equities offer the benefits of commodity investing while avoiding derivatives and futures curves, as seen in the Morningstar Commodity Producers Index family and the Morningstar Global Upstream Natural Resources Index. ® ® Investors’ love affairs with commodities continues unabated. Whether they’re looking for diversification, an inflation hedge, or to speculate on rising prices, investors have plowed hundreds of billions of dollars into commodity-related offerings, including both mutual funds and exchange-traded funds. Investments in commodity mutual funds, for example, have grown to more than $137.6 billion by the end of 2011 from $9.2 billion at the end of 2002. The growth story for commodity-tracking ETFs is even more impressive—assets have skyrocketed to $150.4 billion from $770 million over the same period. Suffice it to say that we’ve come a long way since legendary investor and commodity aficionado Jim Rogers lamented, “Commodities get no respect.” 1 This statement would be far from the truth today. Many Ways to Invest in Commodities There are three avenues to gain exposure to commodities: 1. Physically hold the commodity. Physically backed exposure offers perfect tracking (net a management fee) to the underlying commodity, since the investor actually owns the physical commodity. However, this is really only feasible for high value-to-weight ratio commodities such as gold. Figure 1. Total Assets in Commodity Mutual Funds and Exchange-Traded Funds (US) Commodity-related investment offerings have experienced rapid growth over the last decade. 350 300 Commodity Equities ETFs 250 200 Commodity Equities Mutual Funds Commodity Futures & Physicals ETFs Commodity Futures & Physicals Mutual Funds 150 USD Billions 1. Rogers, Jim. Hot Commodities: How Anyone Can Invest Profitably in the World’s Best Market. 2004. SM 100 50 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2 Morningstar Indexes 2012 13 2. Buy commodity futures. In this strategy, the investor holds futures contracts that obligate the purchase or sale of a set quantity of a commodity, at a set date in the future, and at a set price. Historically, there have been three return drivers of futures-based investments: spot return, collateral yield, and roll yield. There are numerous vehicles available to invest in a futures-based strategy that attempt to optimize these three return drivers. But the futures market can be multifarious, requiring investors to have an understanding of how roll yield works (gains or losses incurred when a contract expires and is rolled into the next one). 3. Purchase equity of the producer. As a final option, one can choose to invest in equity-based products that provide underlying commodities exposure. Equity-Based Exposure to Commodities Investing in equity-based products to gain commodities exposure has broad appeal, as it offers: 3 Convenience: Equity vehicles, such as stocks, are convenient, easy to access, and are less complex than playing the futures market. 3 Wider selections: Using commodity equities also widens the opportunity set to gain exposure to the asset class. Not all commodities have futures associated with them, such as iron ore, timber, water, and coal. 3 Outperformance: It’s also feasible that commodity equities will outperform commodities themselves in a rising price environment. For any given percentage increase in price, a producer’s profits will increase by a greater percentage, all else equal. This leverage to commodity prices is greater for higher-cost producers (those with lower profit margins). Furthermore, higher prices usually mean that more of a company’s potential resources are economical to produce. The investment growth performance of AK Steel and Nucor during the runup in steel prices (which occurred between the recovery from the Asian financial crisis and the peak before the global financial crisis) illustrates the greater leverage to commodity prices for higher-cost producers. A $10,000 investment in AK Steel in 2004 returned more than $190,000 by 2009 as compared to $70,000 for Nucor. AK Steel is one of the highest-cost steel producers in the United States. The company must purchase costly iron ore, and it has significant legacy and financial costs. In contrast, Nucor is one of the country’s most efficient steel producers. The firm has low-cost electric arc furnaces and doesn’t need to purchase iron ore. It has no legacy liabilities and lower financial costs. While AK Steel’s disadvantaged cost position is a serious threat during weak industry conditions, its shareholders benefit from its high degree of leverage during boom times. Commodity Producers—An Analyst’s View There are several considerations that are unique to this investment strategy, including: 3 Cost profiles: As the price of its product changes, a commodity producer’s position on its industry cost curve can have a tremendous effect on its financial performance, and hence the performance of its shares. Smaller, marginal producers with extremely unfavorable cost profiles will tend to see very volatile movements in their share prices from movements in the prices of their relevant commodities. This is because relatively small movements in the prices of the commodities (and in the company revenues) can have an outsized effect on these firms’ earnings. 3 Financial leverage: Highly indebted commodity producers (much like high-cost marginal producers) will tend to see more volatility in their share price performance in response to changing fundamentals. 3 Operational diversification: There are very few pure-play commodity producers in existence. Most producers will have diverse exposure to a number of different commodities or end markets. Take BHP Billiton, for example. The firm produces a wide variety of commodities ranging from coal to diamonds. An investment in a mega-miner such as BHP provides a degree of diversification across commodities and geographies, but still leaves one exposed to firm-specific risk—such as the potential for ill-timed, overpriced acquisitions, which were numerous during the most recent runup in commodity prices. Other company-specific risk factors, such as business and management risk, don’t exist when investing directly in commodities and also warrant consideration. 3 Hedging policies: Some commodity producers may take future price risk off the table by locking in selling prices today. If they do so, they may be either capping future upside in their earnings power, or mitigating potential downside should their product prices subsequently fall below these hedged prices. Heading Upstream: A Route to Commodities That Bypasses the Futures Market 3 Not All Commodity Companies Are Created Equally Morningstar Index Solutions Not all companies or investment options are equal when it comes to gaining exposure to commodities. In most cases, upstream producers—those directly involved in extracting or harvesting the resources from Mother Nature—are the ones that offer the highest leverage to commodities. Downstream companies—those that buy raw commodities and then process or refine them for end markets—tend to afford less leverage to commodities. The most important measure for determining whether a company is an upstream or downstream producer is to look at the correlation to the underlying commodity spot price itself. Upstream producers have higher correlations. In an effort to provide investors with the greatest opportunity to leverage underlying commodities through an equity-based solution, Morningstar offers two differentiated ways to achieve investment exposure to commodity producer equities. Exxon Mobil is a company that many investors might turn to for exposure to energy prices. Indeed, Exxon Mobil generates approximately 80% of its profits from upstream activities, or the actual production of oil and natural gas. These activities benefit from higher oil and gas prices. However, Exxon Mobil’s downstream activities in crude oil refining and chemical manufacturing can suffer from high energy prices, since these commodities are raw materials. In fact, the rise in energy prices has led to lower refined product demand in developed markets. In this way, higher energy prices hurt refining activities on both the cost and demand fronts. Pure exploration and production companies such as Occidental Petroleum, on the other hand, are more leveraged to energy prices than integrated firms such as Exxon Mobil. While the integrated business model affords less leverage to energy prices, this also means less volatility in earnings and equity valuation. We illustrate this in Figure 2. Morningstar® Global Upstream Natural Resources IndexSM The Morningstar Global Upstream Natural Resources Index was launched in 2011. This index measures the performance of stocks issued by companies that have significant business operations in the ownership, management, or production of natural resources in energy, agriculture, precious/industrial metals, timber, and water resources sectors. The index methodology uses a proprietary industry classification system to identify companies within these five natural resource categories. Individual stock weights, as well as category and regional exposure, are capped to promote diversified exposure. Figure 3 demonstrates the stock assignment process for the Morningstar Global Upstream Natural Resources Index. Morningstar® Commodity Producers Index Family An alternative approach is the Commodity Producers Index family, which is designed to offer a high correlation with underlying commodities while supplying upstream commodity exposure to companies that do not hedge against production, (excluding gold mining). The Commodity Producers Index family consists of distinct indexes covering agriculture, energy, metals and mining, and gold. Figure 2. Growth of a $10,000 Investment—Occidental Petroleum vs. Crude Oil vs. Exxon Mobil Pure exploration and production companies are more leveraged to energy prices than integrated firms. 100,000 90,000 80,000 Occidental Petroleum 70,000 60,000 50,000 Crude Oil (Spot Price) Exxon Mobil 40,000 30,000 USD 20,000 10,000 0 2003 2004 2005 2006 2007 2008 Morningstar Indexes 2012 13 4 Figure 3. Morningstar® Global Upstream Natural Resources Index Stock Assignment SM Industry (Secondary Priority) Agriculture Energy Agricultural Inputs Oil & Gas Exploration and Production Farm Products Chemicals Specialty Chemicals Diversified Industrials Integrated Oil & Gas Metals & Mining Aluminum Industrial Metals & Minerals Gold Water Timber Utilities— Diversified Lumber & Wood Production Utilities— Regulated Water REITs Paper & Paper Products Coal & Consumable Fuels 30 30 15 15 Weight (%) 30 30 30 5 5 Conclusion Investors interested in commodities face many investment options. Commodity equities provide investors with exposure to changes in spot commodity prices and expectations for future commodity prices. If investors choose equity-based commodity investing, Morningstar offers several solutions with the Morningstar® Global Upstream Natural Resources Index, and the Morningstar® Commodity Producers Index family. These unique index offerings, developed in conjunction with equity analysts, present indexes that are easy to invest in and based on transparent, noncomplex methodologies. K Oil & Gas Refining & Marketing 30 Stock Limit Rather than embrace a standard market capitalization weighting system for these indexes, Morningstar’s weighting system assigns scores to each company based on its structural leverage to commodity prices and its market capitalization. The weighting schemes used in these indexes include sensitivity factors, as shown in Figure 4, placing higher weights on upstream companies within each index based on their structural leverage to commodities—agricultural inputs or oil and gas exploration, for example. SM Figure 4. Morningstar® Commodity Producer Index Family Construction Process Morningstar Commodity Producer Indexes Global Equities Investable Universe Developed and Emerging Market Countries Liquidity Screen Morningstar Global Equities Indexes Investable securities from U.S., Developed Ex-U.S., and Emerging Market Countries Commodity Producers Screen Industry/ Sensitivity Factor (4 = High, 1 = Low) Agriculture Energy Agricultural Inputs 4 Oil & Gas Exploration and Production 3 Farm & Construction Equipment 3 Farm Products 2 Confectioners 1 Integrated Oil & Gas 2 Coal & Consumable Fuels 1 Metals & Mining Aluminum 1 Diversified Metals & Mining 1 Gold Gold Mining Companies (Producers Only) Steel 1 Precious Metals & Minerals 1 Oil & Gas Refining & Marketing 1 Weighting: Float Market Cap Sensitivity Factor Float Market Cap Sensitivity Factor Float Market Cap Sensitivity Factor Float Market Cap Sensitivity Factor (based on hedging policies)